Yesterday we learned that many Americans have doubts about their current level of retirement readiness. Such concerns are not surprising since the United States is facing an estimated national retirement savings shortfall of $4.13 trillion, according to Employee Benefit Research Institute (EBRI) estimates. How can such a substantial savings deficit possibly be addressed? Another recent EBRI analysis argues that one potential solution is to get more Americans to participate in private-sector retirement savings plans. For example, if employers that do not currently provide their workers with access to some kind of retirement plan instead started to offer a 401(k) comparable to what other firms of the same size already offer, there could be a significant (19.4 percent) reduction in the retirement savings shortfall.
However, even if more people begin to participate in such retirement plans, “leakage” can still be a problem that contributes to Americans’ savings deficits. More than a quarter (27.3 percent) of lower income participants, for instance, are estimated to potentially be at risk of not achieving an 80 percent pre-retirement income replacement rate due to aggregate leakage effects. Some plan sponsors may therefore believe that leakage risk can be dealt with by simply limiting the availability of cash-outs, hardship withdrawals, and 401(k) loans but doing so may also lead to lower contribution rates and more frequent opt-outs, particularly among low-income individuals. As a result, sponsors may want to instead consider implementing financial education initiatives that at the very least aim to inform participants about the potential downsides of tapping into retirement savings early.
Another thing that may be able to help reduce retirement savings shortfalls is professional advice. Indeed, 401(k) participants have a tendency to stay with a plan’s default contribution rate, a problem since an inadequate initial rate of 3 percent is still the norm. Although automatic escalation can address this issue, a way to help make sure that participants do not immediately opt out in response to a higher contribution rate is to also have a financial professional show them projections of what kinds of lifestyles they can afford in retirement based on the different rates of saving. Moreover, research has shown that plan participants who receive professional guidance tend to earn higher annual returns on their investments than individuals who prefer a “do-it-yourself” approach.
Sources: EBRI, Financial Engines, Russell InvestmentsPost author: Charles Couch